FCFF

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Free Cash Flow

FCFF (Free Cash Flow to Firm) and FCFE (Free Cash Flow to Equity)
are both measures used in financial analysis to evaluate a company's
financial health and performance, but they focus on different
perspectives.
Free Cash Flow for Firm
• FCFF represents the cash flow available to all providers of capital, including both
equity and debt holders.
• It's calculated as follows:
FCFF = EBIT(1 - Tax Rate) + Depreciation & Amortization - Capital Expenditure -
Change in Net Working Capital
• where:
• EBIT = Earnings Before Interest and Taxes
• Tax Rate = Corporate tax rate
• Depreciation & Amortization = Non-cash expenses
• Capital Expenditure = Investments in fixed assets
• Change in Net Working Capital = Difference in current assets and current liabilities over a
period
• FCFF measures the cash generated by a firm's operations after considering all
expenses, including reinvestment needs and working capital requirements. It is
often used in discounted cash flow (DCF) analysis to determine the firm's total
value.
Free cash Flow to Equity
• FCFE represents the cash flow available to a company's equity
shareholders after accounting for reinvestment needs.
• It's calculated as follows:
FCFE = FCFF - [Interest × (1 - Tax Rate)] + Net Borrowing
• where:
• Interest = Interest expense on debt
• Net Borrowing = New borrowing - Repayments of debt
• FCFE takes FCFF and adjusts for the cost of servicing debt and any
net borrowing. It measures the cash flow that's available for
distribution to shareholders, for activities like paying dividends, share
buybacks, or investing back into the business.
Assume the following for the company:
•EBIT (Earnings Before Interest and Taxes): $500,000
•Tax Rate: 30%
•Depreciation & Amortization: $50,000
•Capital Expenditure: $100,000
•Change in Net Working Capital: $20,000
•Interest Expense: $50,000
•Net Borrowing: $30,000

• Solution
• FCFF = EBIT(1 - Tax Rate) + Depreciation & Amortization - CapEx - Change
in Net Working Capital
• FCFF = $500,000 * (1 - 0.30) + $50,000 - $100,000 - $20,000
• FCFF = $350,000 + $50,000 - $100,000 - $20,000
• FCFF = $280,000
Assume the following for the company:
•EBIT (Earnings Before Interest and Taxes): $500,000
•Tax Rate: 30%
•Depreciation & Amortization: $50,000
•Capital Expenditure: $100,000
•Change in Net Working Capital: $20,000
•Interest Expense: $50,000
•Net Borrowing: $30,000

Solution
FCFE = FCFF - [Interest × (1 - Tax Rate)] + Net Borrowing
FCFE = $280,000 - [$50,000 × (1 - 0.30)] + $30,000
FCFE = $280,000 - [$50,000 × 0.70] + $30,000
FCFE = $280,000 - $35,000 + $30,000
FCFE = $275,000
Calculate FCFF & FCFE
• Assume the following for the company:
• EBIT (Earnings Before Interest and Taxes): 10,00,000
• Tax Rate: 50%
• Depreciation & Amortization: 1,00,000
• Capital Expenditure: 100,000
• Change in Net Working Capital: 50,000
• Interest Expense: 1,00,000
• Net Borrowing: 1,30,000
Price to Earning Ratio
• The Price-to-Earnings (P/E) ratio is a financial metric used to assess a
company's valuation by comparing its current share price to its
earnings per share (EPS). It's a widely used tool for investors to gauge
how much they are paying for each unit of earnings generated by the
company.
• The formula for calculating the P/E ratio is:
• P/E ratio= Market Price per Share
Earnings per Share (EPS)
Price Earning to Growth (PEG)
The Price/Earnings to Growth (PEG) ratio is a valuation metric used to determine a stock's
value by considering its price-to-earnings (P/E) ratio in relation to its growth rate. It's a more
comprehensive measure than just the
P/E ratio alone, as it incorporates a company's growth prospects into the valuation analysis.
The formula for calculating the PEG ratio is:
PEG ratio= P/E ratio / Annual Earnings Growth Rate

Here's what the components mean:


P/E Ratio: As discussed earlier, it's the ratio of a company's stock price to its earnings per
share (EPS).
Annual Earnings Growth Rate: This represents the rate at which a company's earnings are
growing annually. It can be the historical growth rate or the projected future growth rate.
• The PEG ratio is used to determine if a stock is undervalued, overvalued, or
fairly valued relative to its growth prospects. A PEG ratio of 1 is often
considered fair value. Ratios below 1 might indicate that the stock is
undervalued relative to its earnings growth potential, while ratios above 1
could suggest overvaluation.
• For instance, if a company has a P/E ratio of 20 and an annual earnings
growth rate of 10%, the PEG ratio would be:
• PEG ratio=2010=2PEG ratio=10 / 20​=2
• In this example, a PEG ratio of 2 indicates that the stock might be considered
overvalued relative to its growth rate. However, the interpretation of the PEG
ratio should consider various factors such as the industry, market conditions,
company fundamentals, and the reliability of the growth rate projection.
• It's important to note that the PEG ratio, like any financial metric, should not
be used in isolation and should be considered alongside other factors and
valuation measures when making investment decisions.
Relative PE
The term "Relative PE" typically refers to comparing the Price-to-Earnings (P/E) ratio of one
company to the P/E ratio of another company or to an average P/E ratio within the same industry
or sector. It's a way of assessing whether a particular stock or company is relatively undervalued or
overvalued compared to its peers or the broader market.

For example, if Company A has a P/E ratio of 15 and Company B has a P/E ratio of 20, you might say
that Company A has a lower relative P/E compared to Company B. This comparison might suggest
that Company A is relatively cheaper in terms of earnings multiples when compared to Company B.

Similarly, when comparing a company's P/E ratio to the average P/E ratio of its industry or sector,
investors can gauge whether the company is trading at a premium or discount relative to its peers.

Investors often use relative valuation metrics like relative P/E ratios to make informed investment
decisions. However, it's crucial to consider other factors such as growth prospects, financial health,
market conditions, and qualitative aspects of the companies being compared before drawing
conclusions solely based on relative P/E ratios.
Enterprise value multiplier
• The Enterprise Value Multiple (EVM), also known as the Enterprise Value-to-Sales
(EV/Sales) ratio or simply the Sales Multiple, is a financial metric used to assess a
company's valuation relative to its revenue or sales. It helps investors and analysts
understand how the market values a company's sales compared to its enterprise
value.
• The formula to calculate the Enterprise Value Multiple (EV/Sales) is:
• EV/Sales=Enterprise Value / Total Sales
• Here's a breakdown of the components:
• Enterprise Value (EV): It represents the total value of a company's equity and debt,
taking into account factors such as market capitalization, debt, cash, and
equivalents. The formula for calculating enterprise value is:
Enterprise Value=Market Capitalization+Total Debt−Cash and Cash Equivalents
• Total Sales or Revenue: This refers to a company's total income generated from its
core operations before deducting expenses.
The EV/Sales ratio provides a quick insight into how the market values
a company's sales in relation to its overall enterprise value. A higher
ratio might suggest that the company is being valued at a premium
compared to its sales, indicating potential overvaluation. Conversely, a
lower ratio might imply undervaluation.
However, like any financial metric, the EV/Sales ratio should be used in
conjunction with other valuation measures and factors such as industry
norms, growth prospects, profitability, and market conditions to make
informed investment decisions. Different industries may have different
typical ranges for this ratio, so comparing it to industry peers can often
be more informative.
Selecting the appropriate Enterprise Value Multiple (EVM) or
ratio involves considering several factors to ensure a
meaningful and relevant valuation comparison:
Industry Norms
Company Growth
Profitability and Margins
Market Conditions
Debt Levels and Capital Structure
Company Specifics
Historical Trends
Peer Comparison
Investment Strategy
Valuation of various assets
Real Estate
Stocks and Equities
Fixed Income Securities (Bonds)
Businesses (Company Valuation)
Commodities
Intellectual Property (IP) and Intangible Assets

Each asset class may require specific valuation methods based on its unique
characteristics, market conditions, and available data. The choice of valuation
method often depends on the asset type, purpose of valuation, market factors,
and the level of accuracy required for decision-making
• Real Estate:
• Comparable Sales Approach: Evaluating similar properties recently
sold in the same area to estimate the property's value.
• Income Approach: Estimating the property's value based on the
income it generates, often used for commercial properties.
• Cost Approach: Assessing the cost to replace or reproduce the
property, considering depreciation and improvements.
• Stocks and Equities:
• Comparable Company Analysis (CCA): Comparing financial
metrics and valuation multiples of similar companies to determine a
stock's value.
• Discounted Cash Flow (DCF): Projecting future cash flows and
discounting them back to present value, considering risk and growth
rates.
• Dividend Discount Model (DDM): Valuing a stock based on
expected future dividends, assuming a constant growth rate.
• Fixed Income Securities (Bonds):
• Yield to Maturity (YTM): Calculating the rate of return considering
the bond's current market price, future coupon payments, and maturity.
• Discounted Cash Flow (DCF): Estimating the bond's value by
discounting its future cash flows, including coupon payments and
principal repayment.
• Businesses (Company Valuation):
• Earnings Multiple Approach: Using metrics like P/E ratio,
EV/EBITDA, or P/S ratio based on comparable company analysis.
• Discounted Cash Flow (DCF): Projecting a company's future cash
flows and discounting them to determine the present value of the
business.
• Asset-Based Valuation: Assessing a company's value by calculating
its assets' net worth and subtracting liabilities.
• Commodities:
• Spot Price: Determining the current market price at which the
commodity can be bought or sold for immediate delivery.
• Futures Pricing: Assessing the price of commodities for future
delivery based on supply, demand, storage costs, and market
speculation.
• Intellectual Property (IP) and Intangible Assets:
• Cost Approach: Estimating the cost to replace or reproduce the
intellectual property.
• Market Approach: Assessing the value based on comparable sales or
licensing agreements.
• Income Approach: Estimating the present value of the expected
future cash flows generated by the IP or intangible asset.
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